Income drawdown has taken many forms and had many names between its initial introduction in 1995 as a fairly limited alternative to annuitisation.
It has been described in multiple ways and, even on a practical level, the market has also developed in different ways.
In the traditional insured pension market, drawdown has typically developed as a standalone product which customers must ‘buy’ when moving from accumulation to decumulation.
It was natural for drawdown to be packaged in this way by insurers, as it was a neater fit with the packaging of the annuity products that insurers had offered long before drawdown even existed.
In the self-invested personal pension market, drawdown generally developed differently.
As most Sipp providers did not offer their own annuities, instead offering access to annuities as an option, drawdown was also positioned as an option to those customers – not as a distinct product.
This distinction in the market between a new drawdown product being sold, and a drawdown option being offered inside a single Sipp created an important division in how investments were treated as held where partial drawdown was concerned.
In “drawdown product” schemes, it is more typical for individual investments and cash sums to be treated as ring-fenced within either the non-drawdown or drawdown pot. So a particular unit trust or insured fund will belong to one or other pot.
In “drawdown as an option” schemes, it is more typical for investments to be split notionally across drawdown and non-drawdown pots.
This notional split is updated behind the scenes whenever further benefits are crystallised into the drawdown pot, paid out as drawdown, or when contributions are added to the uncrystallised pot.
Both options are accepted by HM Revenue & Customs from a tax perspective. Each has slight positives and negatives in terms of the management of investments, though for most individuals this will be marginal.
As a result, this distinction has largely slipped under the radar for the 20 plus years since drawdown was introduced.
The Financial Conduct's Authority’s proposed introduction of investment pathways has the potential to change that.
The FCA is proposing that when non-advised individuals put further funds into drawdown they will be offered a pathway investment for that pot. They do not have to take up this investment option but, if they do, it creates significant problems from a notional split perspective.
Consider an individual who has opted for a pathway investment with £50,000 in a drawdown pot and £50,000 in a non-drawdown pot under a “notional split” scheme. We will say they have £10,000 in cash and £40,000 in other investments held outside their £50,000 pathway investment.
In our “notional split” scheme, if that individual chooses to take £1,000 as drawdown, the administrator will not disinvest anything from the pathway investment.